bus fin exam 2

Bond pricing (understand formula, be able to work problems)

1. Lay out the timing and amount of the future cash flows promised 2. Determine the appropriate discount rate for the cash flows 3. Find the present value of the lump-sum principal and the annuity stream of coupons 4. Add the present value of the lump-sum principal and the present value of the coupons to get the price or value of bond

MicroMedia Inc. $1,000 par value bonds are selling for $1,265. Which of the following statements is TRUE? 1. The bonds are selling at a premium to the par value. 2. All of the above are true. 3. The bond market currently requires a rate (yield) less than the coupon rate. 4. The coupon rate is greater than the yield to maturity.

2. All of the above are true

Which of the following statements about the relationship between yield to maturity and bond prices is FALSE? 1. A bond selling at a discount means that the coupon rate is less than the yield to maturity. 2. A bond selling at a premium means that the coupon rate is greater than the yield to maturity. 3. When the yield to maturity and coupon rate are the same, the bond is called a par value bond. 4. When interest rates go up, bond prices go up.

4. when interest rates go up, bond prices go up what would be true? When interest rates go up, bond prices fall.

Rogue Recovery Inc. wishes to issue new bonds but is uncertain how the market would set the yield to maturity. The bonds would be 20-year, 7% annual coupon bonds with a $1,000 par value. The firm has determined that these bonds would sell for $1,050 each. What is the yield to maturity for these bonds?

6.54%

Yield curve (be able to work problems)

A yield curve is a depiction of the relationship between the interest rate and the maturity date of a financial instrument. Although most yield curves tend to be upward sloping, they can take on various shapes, such as being downward sloping or inverted and flat, over time.

Espresso Petroleum Inc. has a contractual option to buy back, prior to maturity, bonds the firm issued five years ago. This is an example of what type of bond? Group of answer choices

Callable bond

What is EAR/APY?

EAR: Effective annual rate. True rate of return to the lender and true cost of borrowing to the borrower AKA APY: annual percentage yield on an investement, calcuated from a given APR and frequency of compounding (m) by using the equation

Annual vs. semiannual bond calculations (be able to work problems).

Semiannual bonds: the annual coupon is divided by 2, number of years is multiplied by 2, and YTM is divided by 2. Coupon = (coupon rate * 1000)/2 r = YTM/2

Big House Nursery Inc. has issued 20-year $1,000 face value, 8% annual coupon bonds, with a yield to maturity of 10%. The current price of the bond is ________.

$829.73 N= 20 I/Y = 10 PV = ? PMT = -80 FV = -1000 CPT = 829.73

The ExecUfind Corporation has issued 20-year semiannual coupon bonds with a face value of $1,000. If the annual coupon rate is 10% and the current yield to maturity is 12%, what is the firm's current price per bond? Group of answer choices

$849.54

What is APR?

Annual percentage rate Most common rate quoted, annual rate based on interest being computed once a year.

What is yield to maturity (YTM)?

expected rate of return based on price of bond

The ________ is the expiration date of the bond.

maturity date

Fisher effect (understand formula, be able to work problems)

r = r* + h + (r* x h) ~~ r* + h

Which of the following are issued with the shortest time to maturity? 1. Treasury bills 2. Treasury notes 3. Treasury stocks 4. Treasury bonds

treasury bills

Computing YTM (be able to work problems).

use TVM equation with PMT, PV, n, and FV

Creative Solutions Inc. has issued 10-year $1,000 face value, 8% annual coupon bonds, with a yield to maturity of 9.0%. The annual interest payment for the bond is ________

$80 0.08*1000

The ________ is the interest rate printed on the bond.

coupon rate

A basis point is ________.

one-hundredth of a percentage point

Bond ratings

Produced by Moody's, Standard and Poor's, and Fitch. Assist issuing companies establish a yield on newly issued bonds.

When the ________ is less than the yield to maturity, the bond sells at a/the ________ the par value.

coupon rate; discount to

The ________ is the face value of the bond.

par value

Treasury bills, treasury notes and treasury bonds.

T bills: zero-coupon, pure discount securities with materials for up to a year. T notes: 2-10 year maturities T bonds: greater than 10 year maturities when first issued all risk free. treasury marker is very large. biggest investor is China.

The ________ is the regular interest payment of the bond.

coupon

Bonds are sometimes called ________ securities because they pay set amounts on specific future dates.

fixed income

Components of interest rates

interest rates decomposition: r = f (rf, dp, mp) r = f(r*, h, dp, mp) rf = risk free interest rates r* = real risk free interest rates h = expected inflation dp = default risk premium mp = maturity (term) risk premium

A bond is a ________ instrument by which a borrower of funds agrees to pay back the funds with interest on specific dates in the future.

long term debt

The ________ is the yield an individual would receive if the individual purchased the bond today and held the bond to the end of its life.

yield to maturity

Nominal and real interest rates (understand formula, be able to work problems).

nominal risk free rate: rate of interest earned on a risk free investment such as a bank CD or treasury security real rate of interest: adjusts for the erosion of purchasing power caused by inflation

Treasury ________ and ________ are semiannual bonds, while Treasury ________ are zero-coupon instruments.

notes; bonds; bills

As the rating of a bond increases (for example, from A, to AA, to AAA), it generally means that ________.

the credit rating increases, the default risk decreases, and the required rate of return decreases

"Junk" bonds are a street name for ________ grade bonds.

speculative

The ________ is a market derived interest rate used to discount the future cash flows of the bond.

yield to maturity

Key components of a bond.

par value, coupon rate, coupon, maturity date, yield to maturity

Annual and periodic interest rates (understand formula, be able to work problems)

EAR=(1+APR/m)^m - 1

Zero coupon bond pricing (understand formula, be able to work problems)

Known as pure discount bonds and sold at a discount from face value. Do not pay any interest over the life of the bond. At maturity, the investor receives the par value, usually $1000. Price is calculated by discounting its par value at the prevailing discount rate or yield to maturity.

More bond features (e.g. callable bonds).

callable bond, yield to call, putable bond, convertible bond, floating rate bond, prime rate, income bond, exotic bond